A housing-rescue bubble

Congress hopes to pass a bill soon that aims to rescue enough at-risk homeowners to put a price floor under a collapsing housing market. In theory, everyone benefits. In practice, well, the rescue plan itself might end up needing a rescue, at taxpayers' expense.

Lawmakers say they justify putting federal money at risk during this housing recession because a high rate of foreclosures is leaving too many neighborhoods with abandoned and neglected houses – about 19 million – dragging down home prices for others, fostering crime, and eroding the economy.

Also, they say, the Federal Reserve put up risky money in March for an emergency bailout of creditors for Bear Stearns investment bank. If Wall Street's bacon can get saved, why not Main Street's?

While those points may well be grounds for federal action, the bill that is likely to pass could end up committing the same mistake careless lenders and borrowers did in inflating the housing bubble: It assumes prices will soon rise and that the new government-backed loans to be negotiated in coming months won't go belly up. The bill, in other words, sets up Uncle Sam to try and catch a falling dagger.

The heart of the measure would allow the Federal Housing Administration to insure up to $300 billion in new loans for at-risk borrowers, but only if lenders take a hit by volunteering to issue a new loan at 15 percent below the appraised value of the borrowers' homes.

Sure, borrowers would need to meet strict criteria and show they have the income and credit record to accept the new, lower-interest mortgages. And they must actually be living in the home, which shoos away many speculators. (Studies show a majority of the foreclosures so far involved financial misrepresentations by the borrower.)

But who can accurately appraise a home's worth in a market that has seen a 16 percent drop in prices nationally over the past year? Collateral in many houses is still fading like a Cheshire cat's grin. Congress is betting taxpayers' money on a price bottom that doesn't yet exist.

And what's to keep lenders from simply pushing the most risky borrowers into this program? Or borrowers from purposely missing loan payments to qualify for this government handout?

The Congressional Budget Office estimates that the FHA would issue 400,000 loans worth $68 billion, out of some 2.2 million borrowers now at risk. But about a third of those new loans would go bad, the CBO says.

Knowing that, Congress hopes to pay for those bad loans by imposing a fee on healthy borrowers who get loans backed by government-sponsored Fannie Mae and Freddie Mac. That may spare taxpayers for a while, but the money from the fees may reach only $700 million.

The bill's backers say the ultimate cost to taxpayers may be only $2.7 billion – chump change in Washington. But that assumes home prices start to climb soon.

The reality is that lawmakers want to look as if they're doing something about the housing crisis before an election and please the powerful lobbies for house-builders and real estate agents.

Lending money in a falling market is a fool's errand. Taxpayers should not be made the fool by this bill. Congress needs to start over.